Doctoral Dissertation Research: An Experimental Investigation of Employment Protection and Labor Substitutability

New York University, New York NY

Investigators

Abstract

Project Abstract Understanding the effects of institutions on labor market outcomes has been a crucial research agenda in economics. Which institutional factors allow labor markets with incomplete contracts to achieve economic efficiency, and do these factors affect how a given surplus is split? More specifically, we want to know how the flexibility of a workers contract - i.e. wage flexibility and the possibility of firing - and the ability to replace a worker determine market outcomes. Despite strongly held beliefs and common intuitions on the issue, the empirical evidence is not conclusive. We present an experimental design to investigate how efficiency and distribution of production surplus change in a worker-firm relationship when key institutional factors are varied, in particular employment protection and substitutability of labor. Methodologically, we argue in the proposal that firm-worker relations are best modeled using an indefinite horizon. Consequently, we set up the interaction as a repeated gift exchange game with random termination. Moreover, we elicit beliefs to investigate whether any differences in behavior can be explained by agents' perceptions about their alternatives to a given relationship. The failure of standard equilibrium concepts to discriminate between treatments motivates a discussion of equilibrium selection mechanisms and alternative theories to derive sharper predictions, with our collected data on beliefs and choices providing guidance. Our project's contribution to the field can be summarized as follows: First, this project goes beyond existing worker-firm gift exchange experiments in that we model worker-firm relationship as a repeated game with indefinite horizon. This design choice is motivated by our focus in understanding institutional effects, and allows cooperation to be sustained theoretically, without reference to behavioral (fair/reciprocal) types. We also take effects of employment protection and substitutability of labor to be most salient when the firm-worker relation is of indefinite horizon. Second, we take a step ahead in exploring how agents' beliefs affect their actions in a firm-worker relationship. We hope that our findings will shed light on how beliefs on "outside options" (such as firm's beliefs on expected payoffs if they replaced the current worker with another) affect strategy formation and equilibrium selection in the context of infinitely repeated games. Third, we investigate how the ability to replace a worker with a new one as opposed to the ability to dismiss her without replacement affects efficiency, distribution of production surplus and unemployment differentially in an economy. Again, to our knowledge, our project is the first to make this distinction experimentally. We take this to be crucial for understanding effects of hiring frictions on market outcomes in terms of efficiency and distribution. Our project has immediate relevance for labor market policies since we look precisely at efficiency and distribution, which are key target variables for policy. Moreover, our design allows conclusions about the link between institutional structure and unemployment. Although our experiment is limited to 3 treatments in consideration of feasibility and simplicity, we intend for it to become the basis of a broader research agenda investigating institutional structure on market outcomes. The extent of public information in the market and individual versus collective bargaining are but two examples.